Is it Smart to Use Your IRA to Buy Your First House?

By Chika

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Last Updated: January 19, 2023

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If you're looking to buy your first house, you could be considering several financing options.

Perhaps, one of the options on your checklist is taking money out of a retirement account like an IRA to fund the purchase of your first home. 

However, before you take this option, it is important you consider both the short- and long-term effects and implications of making a withdrawal from your IRA. In this article, we examine if withdrawing from your IRA to purchase your home is a good option. 

 

 

Can you use your IRA to buy a home?

An IRA is usually to assist you in securing your future financially.

You typically have to wait until you are 59 1/2 years old to begin making withdrawals. You normally have to pay a 10% penalty on the amount removed if you withdraw money from the account before the age of 59 1/2. Additionally, taxes will be due on the payout.

You could, however, be able to withdraw money from the account before turning 59 1/2 without being penalized in some situations. The purchase of a first home qualifies as an exemption from the early withdrawal penalty.

 

How to Use an IRA to Purchase a Home

If you choose to withdraw funds from your IRA to use toward a house purchase, you must first determine your eligibility.

For the first-time home buyer, the IRS permits a withdrawal from an IRA of up to $10,000.

You must have never previously owned a main property to qualify as a first-time home buyer. A married couple can take $10,000 from each of their IRAs for a combined withdrawal of $20,000 that can be utilized as a down payment,thanks to the $10,000 exemption that is available to every individual.

You could be eligible to assist others in getting their first home in addition to buying your own. Owners of IRAs are permitted to make penalty-free withdrawals to assist their parents, grandparents, or children who are buying their first house.

The lifetime cap for withdrawals for first-time homebuyers is, however, $10,000. Your withdrawals must not exceed $10,000 in total to avoid the early withdrawal penalty.

Although there are no penalties associated with early IRA distributions for the purchase of a first home, you should be prepared to pay taxes on the amount removed. 

For instance, a $10,000 withdrawal for a property purchase will result in $2,200 in taxes if you are in the 22% tax bracket. The amount of taxes owed for a couple in the 24% tax bracket who withdraws $20,000 is $4,800.

 

 

How to Withdraw From a Roth IRA for a Home Purchase

The rules are a little bit different for people who want to withdraw money from a Roth IRA as opposed to a traditional IRA.

If your Roth IRA is at least five years old, you can take funds without incurring penalties before retirement age. You won't be charged taxes if you withdraw any amount up to the whole amount you contributed.

You may choose to withdraw a portion of the Roth IRA earnings in addition to your contributions. The first-time homeowner exemption allows you to take an extra $10,000 from your earnings. 

You might wish to look at calculations beforehand to determine how your retirement money might be affected. Assuming a 6% annual return, taking $10,000 out of an IRA at age 30 would cost $57,000 in retirement.

 

 

Alternative Options to Consider When Buying a Home

Withdrawing from your IRA to fund the purchase of your first home may not be a good idea.

The amount you have contributed so far would not grow and earn interest over decades. This means potentially losing tens of thousands of dollars that could have been added to your retirement account.

However, there are some other ways you can fund the purchase of your home without withdrawing from your IRA

 

401(K)

A house purchase loan may be available via some 401(k) plans.

There are normally no fees or taxes associated with 401(k) loan withdrawals, but you will be required to pay interest. Borrowing money from a 401(k) might harm retirement chances, much like the IRA.

 

 IRA Rollover

You can choose to borrow the funds rather than take a withdrawal from your IRA.

Although you technically can't borrow money from a regular or Roth IRA, you can access funds for 60 days through a process known as a tax-free rollover. The most effective technique to obtain money for the down payment may be through the tax-free rollover.

You may be eligible for higher financing, sealing the deal on the property purchase, as long as you deposit the funds into the IRA (whether it's the one you withdrew from or a different one) within 60 days after the withdrawal.

Penalties and income taxes, including state taxes, are assessed if you don't.

 

Final thoughts

You may take out up to $10,000 from your conventional IRA and use it to purchase, construct, or remodel a house if you meet the requirements for first-time homebuyers.

If you hold a Roth IRA for at least five years, you can take your contributions at any time, without incurring taxes or penalties, for any reason.

But this does not imply that utilizing your IRA to finance a house purchase is a smart move.

  • Raiding your retirement account can have long-term consequences.
  • You're losing the tax-free growth over time, and you're depleting something that you've worked hard to save.
  • You are also missing out on years of compound interest.
  • Plus the restrictions on IRA contributions make it challenging to rebuild these funds.

Look at the big picture to make sure you're doing the right thing not only in terms of present taxes and penalties, but also in terms of your future security.

If you have no other alternatives and must utilize an IRA to pay for your house purchase, you should rethink when to make the purchase. Waiting until you have the down payment saved while keeping your retirement funds intact generally makes more financial sense.

Photo by MART PRODUCTION

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